Dividend Policy # 1. Stable Dividend Policy:

When a firm constantly pays a fixed amount of dividends and maintains it for all the times to come regardless of fluctuations in the level of its earnings, it is said to have pursued a relatively stable dividend policy. In such a policy, stockholders are assured of fixed dividends per share.

During periods of prosperity the firm withholds all extra-ordinary income of the business to use it to maintain dividend amount during lean years. Stability of dividend policy does not mean stagnation in dividend pay-out ratio. In fact, slow but steady change is the prime feature of stable dividend policy.

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When the firm’s earnings tend to rise regularly and the management feels satisfied that increased earnings are sustainable and permanent, amount of dividend per share is increased. Likewise, dividend will not be allowed to decline in correspondence with a fall in business earnings until it is felt that the firm will not be able to recover from the setback.

Figure 41.1. portrays behaviour of earnings and dividends of Swatantra Company Ltd over a period of 80 years. It is evident from the figure that dividend per share registers slow and steady growth despite earning fluctuations. The firm experienced a major set-back during 1990 because of labour strike and level of earning dipped down below the dividend level.

The management, however, tried their level best to maintain dividend rate. After 1990, the firm’s earning position improved remarkably. In 2001 when the management felt that increased earnings are permanent and will afford the increased dividends that level of dividend was slightly adjusted upward.

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In actual practice, most of the companies follow stable dividend policy because of the following reasons:

1. Finns regularly paying dividends at a fixed rate have always high credit standing in the market. They can raise as much funds as they like from the market because of widespread demand of their shares.

2. Stable dividend policy fosters a rise in share values. Investors generally pay higher premium to shares promising a certainty of dividend income than to those with fluctuating dividends because of risks inherent in the latter. Those who derive their regular income from dividend would always prefer to hold such shares as assure certainty of dividend.

3. Since dividends communicate information to investors about a firm’s profitability and managerial efficiency, naturally firm pursuing stable dividend policy enjoys a great confidence of shareholders. This may be immensely useful in fund raising activity of the firm and will also give boost to the morale of the management.

4. Firm with stable policy can very easily formulate long-term financial planning because the finance manager can in that case correctly estimate future supply and demand of capital in the firm.

However, in designing stable dividend policy finance manager should see that dividend pay-out ratio is not fixed at a level that the firm may subsequently find it difficult to sustain. It would be worthwhile to keep in mind future earning power of the firm while determining dividend rate.

Stability in level of earnings indeed is a basic condition for pursuing this policy. Firms with erratic fluctuations in level of earnings may find it extremely difficult to follow stable dividend policy. Public utility concerns and others manufacturing staple products of daily consumption generally follow this policy because of relatively less variations in their earnings.

Dividend Policy # 2. Policy of no Immediate Dividend:

Very often management may decide to declare no dividend despite large earnings of the firm.

This policy is generally pursued in the following circumstances:

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1. A new and rapidly growing concern which needs tidy amount of funds to finance the expansion programmes.

2. When the firm’s access to capital market is difficult or when availability of funds is costlier.

3. Where shareholders have agreed to accept higher return in future or they have strong preference for long-term capital gains as opposed to short-term dividend income.

Policy of no immediate dividends should be followed by issue of bonus shares so that the firm’s capital increases and amount of reserves and surplus is reduced or the firm’s stock should be split into small lots so as to keep dividend per share low while providing large dividend amounts to stockholders.

This course of action would be necessary to keep share prices within limits. Detailed account of significance of stock dividends has been given under the heading stock dividends.

Dividend Policy # 3. Policy of Regular Extra Dividends:

Firms following regular dividend policy pay out dividends constantly to stockholders at constant rate and do not change the pay-out ratio unless it is believed that changes in earnings are permanent. When profits of the firm swell, management may decide to distribute a part of the increased earnings as extra dividend instead of increasing regular dividend pay-out ratio.

Extra dividends are declared only in the year when the earnings exceed the annual dividend requirement by some given amount. Whether or not the extra dividends will be declared depends on a number of factors, among which the important ones are expected funds requirements, the desired level of liquidity, and expectations about future earning levels.

Such a policy gives impression to the stockholders that extra dividends have been paid because the firm has made extra ordinary earnings which will be skipped subsequently when business earnings will drop to normal level. With this policy, the firm’s credit standing and so its share values are not likely to be adversely affected with omission of extra dividends in future.

However, a firm following the policy of regular and extra dividends year after year may give a wrong impression among the stockholders who may treat extra dividends as part of regular dividends with the result that they may react very strongly to omission of extra dividends in future when earnings of the firm do not warrant distribution of such dividends and firm may lose confidence of stockholders and its credit standing in the market.

It is, therefore, pertinent for the management to make it crystal clear in policy announcement that a regular dividend rate will be paid under normal circumstances with the possibility of extra dividends only when earnings power and other conditions warrant.

Further, to distinguish between regular and extra dividends, they should be clearly labelled to that effect. Bigger companies have been found assigning different numbers to regular and extra dividends.

It is only when extraordinary earnings become a permanent feature and management feels that increased earnings will support an increase in dividend rate permanently that extra dividends become a part of regular dividend and dividend rate is raised accordingly.

Dividend Policy # 4. Policy of Regular Stock Dividends:

Firm pursuing this policy pays dividends in stock instead of cash. Stocks to pay dividends are designated as ‘bonus shares’ which are very frequently used to capitalize reinvested earnings of the firm. Issue of bonus shares does not at all affect liquidity position of the firm; it increases, indeed, the share holding of residual owners but not their equity in the firm.

Such a policy is generally followed under the following circumstances:

(1) When the firm needs cash generated by earnings to cover its modernisation and expansion programmes.

(2) When the firm is deficient of cash despite high earnings. This is particularly true if the firm’s sales were affected through credit and entire sale proceeds are tied in receivables.

It may be noted that it may be dangerous to pursue the policy of stock dividend regularly for a long period of time because in that case earnings per share will decline sharply, value of shares tends to plumb and credit standing of the firm receives big jolt.

Besides, stockholders cannot remain satisfied with receiving dividends in stocks. They may cry for cash dividends after some time and may even force the management to change.

Dividend Policy # 5. Policy to Pay Irregular Dividends:

Firm following this policy does not pay out fixed amount of dividend per share. Instead, dividend per share is varied in correspondence with change in earning level; larger the earnings means higher the dividend and the vice-versa. This policy is based on management’s belief that shareholders are entitled to dividend only when earning and liquidity position of the firm warrant.

Generally, this policy is adopted by firms with unstable earnings. Firms with fluctuating investment opportunities may find this policy useful. A large part of profits may be ploughed back in the year when a firm has number of highly profitable investment opportunities.

In the subsequent year, when the firm will have no or limited investment opportunities to seize, the management may distribute larger portion of earnings which would otherwise have remained unutilized.